Characteristics of Convertible Bonds and indexation to inflation
Question
With reference to Convertible Bonds, consider the following statements: Which of the statements given above is/are correct?
- 1.
As there is an option to exchange the bond for equity, Convertible Bonds pay a lower rate of interest.
- 2.
The option to convert to equity affords the bondholder a degree of indexation to rising consumer prices.
Options
1 only
2 only
Both 1 and 2
Neither 1 nor 2
Explanation
Both statements are correct. A convertible bond gives the holder the right to convert the debt into equity shares. Because this equity upside is highly valuable, investors accept a lower rate of interest (coupon rate) compared to standard corporate bonds. Furthermore, because equity shares generally appreciate alongside inflation and corporate growth, the conversion option inherently provides a degree of indexation against rising consumer prices.
Answer: (c).
Question details
Year
2022
Paper
GS Paper 1
Question
Q65
Subject
Economy
Sub-topic
Financial Markets & Instruments
Type
Statement-based
Difficulty
Medium
Nature
Static
Source hint
Corporate Debt Securities / Convertible Bond Arbitrage Hedging
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